How To Find Out What You Should Invest In Stocks

Transcription

1 CHAPTER 3: ANSWERS TO CONCEPTS IN REVIEW 3.1 The Internet only a few years ago was used to locate the lowest transaction costs, but today the Internet not only provides low cost investing, but also a multitude of information sources designed to assist the individual investor in the decision making process. 3.2 The four types of online investment tools are as follows: a. Planning. Online calculators and worksheets help you find answers to your financial planning and investing questions. b. Screening. Screening tools help you sort through huge databases of stocks and mutual funds to find those that have specific characteristics. c. Charting. This technique allows you to plot the performance of a stock or a group of stocks over a specified time period. d. Tracking. This tool allows the investor to track his or her investment, to be alerted whenever an analyst changes the rating, or to indicate how well the portfolio is diversified among major asset classes. 3.3 As for the advantages of online investing, it is now possible for even the novice investors to participate in the stock markets with a huge amount of information available at their fingertips to assist in making their decisions to invest. On the con side, trading on the Internet requires that investors exercise the same caution they would if they were getting information from a human broker. Furthermore, you don t have the safety net of dealing with a human who may be suggesting that you exercise additional caution. The ease of the point-and-click investing can be the financial downfall of inexperienced investors. 3.4 Descriptive information is factual information on past behavior of the economy, the market, or a given investment vehicle. Analytical information, on the other hand, tends to analyze existing data and make projections, and is quite often a source of recommendations for potential investments. The investor must evaluate whether the costs of acquiring the information are justified by the potential increase in return. There are either direct or indirect costs associated with information gathering. Direct costs include subscription fees and advisor s fees. Indirect costs include the time involved to gather information. 3.5 The Wall Street Journal, published by the Dow Jones, is perhaps the most popular source of financial news in this country. Published daily, it provides daily price quotations on thousands of securities. It also has a wealth of world reports, national reports, and regional and corporate news. Regular features, like Your Money Matters, address topics of interest to individual investors. Barron s, on the other hand, is a weekly publication also published by Dow Jones. However, the articles in Barron s are generally more in-depth and directed to financial issues than those in The Wall Street Journal. Barron s also has special interest columns like Up and Down Wall Street. In addition, there are current price quotations and summary statistics on a Fundamentals of Investing, by Gitman and Joehnk 1

2 variety of investment vehicles. Other sources of financial news include Investor s Daily, the Commercial and Financial Chronicle and the Journal of Commerce. General news is available from a variety of published sources, especially daily newspapers in the local community. Many business people also rely on daily papers that have national reputations in the political and economic arena such as The New York Times and The Los Angeles Times. USA Today is a national daily newspaper containing a Money section devoted to business and personal financial news. Time and Newsweek are also major periodicals in the general news category. Business news articles and statistics on general business and economic activities in the United States and abroad can be found in The Wall Street Journal and in such magazines as Newsweek, Time, U.S. News & World Report, Business Week, Fortune, Business Month, Nation s Business, Federal Reserve Bulletin, and the Survey of Current Business. A variety of articles discussing the activities of securities markets and corporations can be found in The Wall Street Journal, Barron s, Investor s Daily, Forbes, Kiplinger s Personal Finance Magazine, Money, and Smart Money (a new WSJ publication). The last three are oriented toward individual investors and managing personal finances. Local metropolitan newspapers also provide information on securities of local interest 3.6 a. The stockholder s report, also called the annual report, is an annual publication of publicly held corporations. These reports are usually free and contain a wealth of descriptive and analytical information, including financial statements, about the firm. b. Comparative data sources enable investors to analyze the financial condition of companies and are typically grouped by industry and size of firm. These include Dun & Bradstreet s Key Business Ratios, Robert Morris and Associates Annual Statement Studies, the Quarterly Financial Report for Manufacturing Corporations, and the Almanac of Business and Industrial Financial Ratios. c. Standard and Poor s Stock Reports is a major service of the Standard and Poor s Corporation. It contains up-to-date reports on numerous firms, including a summary of the firm s financial history, its current financial situation, and for NYSE companies, an opinion on the firm s future prospects. a. The Moody s Handbook of Common Stocks provides detailed financial information on over 1,000 common stocks. e. Value Line Investment Survey offers ratings for over 1,700 of the most widely held stocks with full-page reports including financial data, descriptions, analysis, and advice. 3.7 a. The prospectus is part of the registration statement required by the SEC on a new security issue. It describes in detail the key aspects of the issuer, its management and financial position, and the security to be issued. Brokerage firms provide prospectuses at no cost to their clients. (Note: This information source is available only when a firm is making an issue of new securities.) b. Back office research reports present analyses and recommendations on the current and future prospects for the security markets, specific industries, and specific securities. These are prepared by brokerage firm research staffs and are available (usually free of charge) to existing as well as potential clients. c. Investment letters are the analysts conclusions, and recommendations of various experts. Common examples of investment letters are The Dines Letter, the Wellington Letter, The Zweig Forecast, and Holt Investment Advisory. Although some investment letters concentrate Fundamentals of Investing, by Gitman and Joehnk 2

3 on specific types of securities, others are concerned solely with assessing the economy and/or security markets. The cost varies between $75 and $300 per year for a subscription to these (generally) weekly or monthly letters. d. Price quotations include the current prices and price statistics for various types of securities. Almost all brokerage houses have automated devices for obtaining up-to-the-minute quotations. Many firms still use a ticker, a lighted screen on which stock transactions made on the floor of the exchange are reported immediately as they occur. The stock names are shown in an abbreviated form called ticker symbols. Recently, more firms have acquired sophisticated computer terminals to more efficiently provide up-to-the-minute stock price information. The most common sources of such information, however, are the daily newspaper and The Wall Street Journal, which contains current quotations on numerous short-investment vehicles. Barron s and Investor s Daily also provide a wealth of security price quotations. 3.8 Electronic and on-line investment information allows individual investors to get timely historical and current information such as stock quotes and economic and financial information. In addition, investors may use their personal computer (PC) to access CD-ROM and diskettes for investment information, financial data, and/or analysis software. One of the more popular on-line services is the Dow Jones News/Retrieval service that gives investors access to The Wall Street Journal and Barron's articles among others. CompuServe subscribers can access SEC filings, corporate insider trading information and articles from more than 800 periodicals. Most of the electronic on-line services charge either initial, monthly, and/or usage fees. Charges sometimes vary depending on the time of day the service is accessed. 3.9 Phony press releases containing information that appears detrimental to the profitability of the firm and thus its stocks are but one form of on-line scam. Also some hot tips are posted on bulletin boards or places like Yahoo and invite unknowing investors to buy on bogus information. In addition the text refers to people who will pan a stock and represent themselves as an investment expert. The best advice to avoid these types of scams is to follow the rules of good investing and always do the research to know what you are buying Stock market averages and indexes are used to measure the general behavior of securities markets. Averages reflect the arithmetic average price behavior of a certain group of stocks at a given point in time, whereas indexes measure the current price behavior of the group relative to a base value set at an earlier point in time. Averages and indexes provide a convenient way of capturing the general mood of the market. When the averages or indexes reflect an upward trend in prices, a bull market is said to exist. Likewise, when these measures exhibit a downward trend, a bear market exists a. The four Dow Jones Averages include the Dow Jones Industrial Average (thirty high-quality industrial stocks), the Dow Jones Transportation Average (twenty transportation stocks), the Dow Jones Utility Average (fifteen public utility stocks), the Dow Jones 65 Stocks Composite Average (includes all of the above) and Global-US (market weighted index that reflects 80% of the total market value for nine specific economic sectors). b. The six Standard and Poor s (S&P) Indexes include the S&P 400 Industrial Index (400 industrial firms), the Transportation Index (twenty transportation companies), the Utilities Index (forty public utility stocks), the Financials Index (forty financial stocks), the Composite Index (includes the 500 stocks in the S&P indexes mentioned above), the Midcap Index (400 medium-sized companies), the small-cap index (made up of 600 small-sized Fundamentals of Investing, by Gitman and Joehnk 3

4 companies); and the 1500 index, which includes all stocks in the composite, midcap, and smallcap indexes. Nearly all these indexes can be found in financial newspapers such as The Wall Street Journal, Barron s, Investor s Daily, and local newspapers in major metropolitan areas a. The New York Stock Exchange Index includes all of the over 2,800 stocks listed on the New York Stock Exchange. It is calculated in a manner similar to the S&P Indexes. This index reflects the value of the stocks listed on the NYSE relative to a base of 50 set at December 31, b. The American Stock Exchange Index reflects the price of shares on the American Stock Exchange relative to a base of 100 set on August 31, c. The Nasdaq Indexes reflect the behavior of the over-the-counter market. The most popular, the OTC Composite Index, is calculated using more than 6,400 domestic common stocks traded on the Nasdaq system. The index is based on a value of 100 set on February 5, Other Nasdaq indexes include industrials, insurance, banking, national market composite, and national market industrials. d. The Value Line Composite Average includes the approximately 1,700 stocks in the Value Line Investment Survey and traded on a broad cross section of exchanges as well as in the over-the-counter market. The base of 100 reflects the June 30, 1961, average of the stocks. e. The Wilshire 5000 Index, represents the total dollar value (in billions of dollars) of 5,000 actively traded stocks, including those on the NYSE and the AMEX in addition to active OTC stocks a. Bond yields capture the behavior of market interest rates and represent a type of summary measure of the return an investor would receive on a bond if it were held to maturity. They are reported as an annual rate of return. b. The Dow Jones Bond Averages, quoted in The Wall Street Journal and Barron s,include a utility bond average, an industrial bond average, and a composite bond average. Each of these averages reflects the simple mathematical average of the closing prices rather than yields for each group of bonds included. c. Since the New York Stock Exchange is the dominant organized exchange for bond trading, the New York Stock Exchange Bond Statistics, such as the number of issues traded; the number that advanced, declined, or remained unchanged; the number of new highs and new lows; and total sales volume in dollars, provide valuable information to present and potential bond market investors Stockbrokers help investors buy and sell securities. Besides this major role, full-service stockbrokers provide clients with several other benefits. For example, most brokerage firms offer their clients a wide variety of information. Many of them have research staffs that periodically review published economic, market, industry, or company behavior forecasts and make recommendations to their clients as to which securities they should buy or sell. Every month they mail investors a record of transactions for that month with a total ending balance. Some brokerage firms also make arrangements to transfer funds from the sale of securities directly to an investor s savings account, where they can earn interest. Many brokers have reference libraries that clients can use to research securities. They can provide up-to-the-minute stock price quotations. Many brokerage firms will also hold certificates for safekeeping to protect against loss. Fundamentals of Investing, by Gitman and Joehnk 4

5 The major role of the stockbroker is to execute the clients transactions at the best possible price. While it is not necessary to know your stockbroker personally, he or she should understand your investment goals. This should avoid potential conflicts. You should also make sure that the broker does not charge you too much for the services provided and that you are not paying for services that you do not need a. A brokerage account may be either single or joint. Joint accounts are typically between married couples or between parent and child. b. A custodial account is one in which a parent or a guardian will take responsibility for all transactions undertaken on behalf of a minor. c. A cash account is one in which a customer can only use cash to make transactions. This is perhaps the most common type of account. d. A customer who wishes to trade in securities using borrowed money establishes a margin account. By leaving the securities with the brokerage firm as collateral, the customer can borrow a pre-specified amount to trade in securities. Needless to say, the brokerage firm will first verify the customer s creditworthiness before opening a margin account in that customer s name. e. A wrap account is an account in which customers with large portfolios pay the brokerage firm a flat annual fee, typically between 2 and 3 percent of their portfolio s total asset value, to cover the combined costs of a money manager s services and the cost of commissions on their trades. These accounts allow the wealthy investor to conveniently shift the burden of stock-selection decisions to a professional either in-house or independent money manager A market order is an order to buy or sell a security at the best price available at the time the order is placed. It is the quickest way to make securities transactions. A limit order is an order to buy stock at or below or to sell stock at or above a specified price. It is best used when securities prices fluctuate widely. A stop-loss order is an order to buy or sell the stock when its market price reaches or drops below a specified level. It is used primarily by investors who wish to protect themselves from a rapid decline in the price of the stock. The stop-loss order gives them the opportunity to sell the stock when the price declines to the stop price, thereby reducing their potential losses. It becomes a market order and may in fact be executed at a lower price than the price at which the order was initiated Typically, brokers charge either fixed commissions or negotiated commissions commissions mutually agreed upon by the client and broker. Negotiated commissions are also available to investors who maintain large accounts with the broker. The commissions usually vary depending on the services the broker provides to the investor. The major difference between a full-service and discount broker is the full-service broker provides investment advice. Because investing through a discount or deep-discount broker can save from 30 to 80 percent of the commission, the investor must weigh the benefit of advice against the higher commission. Online brokers (also called Internet brokers or Electronic brokers) are typically deep discount brokers through whom investors can execute trades electronically online. These brokers charge very low commissions, but offer little or no research, information or investment advice The steps in making an online stock transaction can be summarized as follows: 1. Go to the brokerage site with your account number and PIN. 2. At your personal trading page, review the information you need. Fundamentals of Investing, by Gitman and Joehnk 5

6 3. Using the order form, place the order. 4. After placing the order, click to see a preview or confirmation. 5. Click on the Place Order button to confirm receipt of your order. Day trading is the opposite of a buy-and-hold strategy since true day traders do not even own stocks overnight. The method is highly risky since it often involves margin and short transactions that may result in total loss. In addition, day traders have high expenses for brokerage commissions, training, and computer equipment Many investors set aside an amount of their capital that is designated for purely speculative purposes and not required for day-to-day survival. In this way, they are not jeopardizing themselves or their loved ones if they suffer heavy losses First, know how to place and confirm your order before you begin trading. Second, verify the stock symbol of the security you wish to buy. Third, use limit orders. Fourth, don t ignore the online reminders that ask you to check and recheck. Fifth, don t get carried away. Sixth, open accounts with two brokers. Lastly, double-check orders for accuracy Few electronic bond trading accounts are available to online investors. Typically, you must find the information on your own and then phone your broker to fill the order. Many firms are developing online bond-trading capabilities in response to customer demand The Securities Investor Protection Corporation (SPIC), a nonprofit membership corporation, was authorized to protect customer accounts against the consequences of financial failure of the brokerage firm. Mediation is an informal, voluntary approach in which you and the broker agree to a third party who facilitates negotiations between the two of you to resolve disputes. If mediation is not pursued or it fails, you may choose arbitration, a formal process whereby you and your broker present the two sides of the argument before a panel of third party individuals Investment advisors are individuals or firms who advise clients about portfolio management. This may be done on a discretionary basis, in which case the advisor has complete control over the client s portfolio. In other cases, the advisor provides investment information and advice, and the client makes his or her own investment decisions. Professional investment advisors are required to register and file regular reports with the SEC under the Investment Advisers Act of 1940; a 1960 amendment gave the SEC broader powers to monitor their activities. However, those who provide investment advice in addition to their primary job responsibility such as financial planners, stockbrokers, bankers, and accountants are not regulated by the Act. Many states have similar legislation. It is important to remember that these laws only protect against fraud and unethical practices. They do not provide the investor any indication of the quality of investment advice. Professional investment advice usually costs between one-quarter of 1 percent and 3 percent annually of the amount of money being managed. For larger portfolios, the fee is in the range of one-quarter percent to three-quarters percent; for small portfolios an annual fee ranging from 2 to 3 percent of the dollar amount of funds managed Investment clubs offer the individual investor access to information and/or advice from a broad range of differently experienced people who have similar attitudes, investments strategies and Fundamentals of Investing, by Gitman and Joehnk 6

7 goals. Also, through the investment club the individual investor can participate in a larger, and probably more diversified, investment portfolio, therefore increasing the probability of earning a favorable return on his or her investments. For the uninitiated investor a club can provide an excellent mechanism for learning key aspects of portfolio construction and investment management. Investment clubs regularly outperform the market and the professional money managers because they buy stocks for the long term instead of trying to time the market. Fundamentals of Investing, by Gitman and Joehnk 7